Trade Wars Will Disrupt Supply Chains, Slow Global Growth

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FILE: An employee works on the assembly line at the Ford Motor Co. Kentucky Truck Plant in Louisville, Kentucky, U.S., on Friday, Oct. 27, 2017. Photographer: Luke Sharrett/Bloomberg

Right now, trade wars are the greatest threat to global growth. And if President Trump implements the threat of tariffs on autos, it could be the tipping point for a global equity selloff.

Today’s auto industry has a complex supply chain. A car assembled in the U.S. might have its engine manufactured in Germany, its transmission system from Mexico and its GPS from South Korea. Such sophisticated supply chains have formed through decades of globalization, which is difficult to unwind. Intermediate products dominate trade, with a growing share between international affiliates of the same company.

Yet the rift with the EU could see U.S. tariffs of US$63 billion on autos and auto parts. And if NAFTA negotiations also stall, then a further US$160 billion of autos and parts could get hit. Targeted trading partners have all promised to retaliate.

If these tariffs come into effect, it may ultimately force some automakers to relocate their production to match local demand. This could reduce the economies of scale and push up prices for the end consumer. Since autos are such a prominent part of global trade, any breaks in the supply chain will be highly disruptive to future growth.

U.S. trade is basically all about carsCensus Bureau 2015, Deutsche Bank Research

Globalized Supply Chains Are Vulnerable

Today’s complex supply chains have not experienced tariffs on this kind of scale. While politicians tend to focus on the direct impacts of tariffs, the knock-on effects can be just as significant as business confidence drops and investment commitments are delayed or cancelled.

Unintended consequences are already emerging. Of the initial US$34 billion of U.S. tariffs coming into effect, it is estimated that 60% will fall on foreign companies operating in China, some of which are American.

In the U.S., two German manufacturers, BMW and Daimler, have made significant commitments to serve the local market and Asia. Their exports to China are a big reason the U.S. runs an auto trade surplus with China. Given the proposed tariffs, the German automakers may be incented to scale back their U.S. footprints, cut jobs and relocate to serve their Chinese markets.

Meanwhile, Harley-Davidson, the iconic U.S. motorcycle manufacturer, has indicated it will move some production offshore to avoid projected tariffs from the EU.

And Volvo Cars, a Chinese-owned company based in Sweden, had recently committed to manufacture autos in South Carolina to not only serve the U.S. market, but also for export to Europe and China. But in light of tariff threats, the company has already flagged it will cool its hiring plans.

This immediate reaction to just the threat of tariffs illustrates the adverse effect such policies can have on industries with complex global supply chains, and the potential to undermine critical drivers of global growth over the past few decades.

What This Means For Investors

As the initial US$34 billion of U.S. tariffs kick in, and China retaliates in equal measure, most economists estimate they will have a benign impact on the global economy. But if these tariffs are extended to autos, and other industries with complex global supply chains, the results are likely to be more severe.

From an investor’s standpoint, fundamental analysis is key to identifying which companies are most vulnerable to trade tariffs. In industries with complex global supply chains, like autos, ranking how quickly companies could mitigate tariffs by reshoring production is a good start to handicapping winners and losers. By comparison, domestically focused companies such as telecommunications, financials and utilities are more insulated from trade shocks.

Geopolitical risks, such as how well political leaders can negotiate while placating their electorate while they ride out dislocations, are also important factors in any investment decision. The length of any standoff and its ultimate outcome are tricky to estimate. The largest global trading regions – NAFTA, the EU and China – are all at odds with the U.S. on fair practices, which creates a challenging backdrop.

We are still in the early stages and volatility is likely to heighten with each retaliation. But among all the negotiations, politicians should realize that if they want the global economy to keep humming along then tariffs on autos could push the economy and markets into the slow lane.

This material contains opinions of the author but not necessarily those of Sun Life Financial or its subsidiaries.

I am an insurance asset management industry veteran with over 30 years’ experience at global financial firms. As CIO of Sun Life Financial, I lead a 240+ global investment team in managing $100+ billion in Sun Life’s own insurance assets, as well as helping to build Sun Lif...